Inflation expectations play a crucial role in households’ and firms’ decisions. Yet, they can be very difficult to measure. We propose a new, indirect way of measuring inflation expectations focusing on the formulation of the survey question. Instead of following the conventional approach that asks consumers directly about their inflation expectations, we ask respondents how much they think their current level of income needs to change for them to be equally well-off and afford the same basket of goods and services one year from now.
Our Question: “Next we are asking you to think about changes in prices during the next 12 months in relation to your income. Given your expectations about developments in prices of goods and services during the next 12 months, how would your income have to change to make you equally well-off relative to your current situation, such that you can buy the same amount of goods and services as today? (For example, if you consider prices will fall by 2% over the next 12 months, you may still be able to buy the same goods and services if your income also decreases by 2%.) To make me equally well off, my income would have to…”
Respondents select from three options: (i) Increase by __%; (ii) Stay about the same; and (iii) Decrease by __%. They fill in the percentages if they select (i) or (iii).
In Hajdini, Knotek, Pedemonte, Rich, Leer, and Schoenle (2022), we show that this measure of Indirect Consumer Inflation Expectations (ICIE):
- Was below 4% in spring 2021 but had moved up to above 6% by late January 2022.
- Reveals that very few individuals had anticipated that deflation would occur over the next 12 months.
- Is strongly correlated with inflation experiences: exploiting our large sample size, US cities that experienced higher inflation had higher inflation expectations, and in an international comparison, consumers in countries with higher levels of realized inflation also had higher inflation expectations.